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Premium Traffic - The Search For Yields

Premium travel yields are on the increase. But can investing in the appropriate product for the ticket price raise airlines’ yields higher

They have been slow in coming, but it looks as if premium travel yields are finally on the upturn.
Passengers travelling in first and business-class seats on international routes rose by 13.8% in July from the level seen the previous year. Most airlines are also reporting improved yields.

For the first half of 2010, even accounting for the losses due to the European airspace closures in April, premium travel was up 11.9%. Numbers for the first seven months suggest an annualized rate of 10%. This is more than double the average 4.5% growth rate in premium travel seen in the years before the recession.

It would seem to be a healthy situation backed by a number of external indicators. World trade is strong and business confidence is high.

But before chief financial officers begin rubbing their hands with glee, it is worth noting that the picture is not as rosy as it looks. To begin with, 2009 figures were dramatically down on 2008. Despite the increases, yields are still 8% down on pre-crisis levels.

And even current growth can be questioned. The latest forecast from the Organization for Economic Cooperation and Development (OECD) shows economies slowing faster than expected. Unresolved travel decisions have now been taken and depleted inventories have been replenished. There has been some slippage in the premium figures in recent months, which is consistent with expecting year on-year growth rates to decelerate in the second half of the year.

Additionally, there is notable regional variation. US airlines are seeing strong growth in yields and revenues but the North Atlantic market, which represents about 30% of revenue, remained sluggish in June, suffering from weak economic conditions in Europe in particular. The number of passengers in this sector, premium and economy travelers combined, rose by only 0.1% during the first half of the year.
“The situation is less positive than when decisions were taken to add capacity,” says Chris Tarry, Analyst at CTAIRA. “We could see a pause in what has been a business class-led recovery.”

The question for airlines is whether they can influence a return to higher yields. Can investment in product win out against external factors such as the state of the economy and market competition?

A return to good times?

Tarry highlights a difference between short-haul and long-haul flights. Short haul is all about frequencies and timings, and investment here is harder to justify. “Product is certainly important in the long-haul business, though,” he says. “But customers won’t pay more than they have to when there is abundant choice. And hubs aggregate demand on intercontinental flights, which also has a strong influence on price.”

So investment counts, but only to keep a carrier standing still in the face of intense competition. “There is also pressure from senior management for corporate travel managers to be increasingly smart with their money,” Tarry warns. “And you have to consider that there is only so much that can be done with product.

What can be improved once the seat lies flat?”

Nevertheless, airline case studies reveal stirrings of optimism about product investment decisions. Singapore Airlines posted a net profit of $187 million (SGD253 million) in the first quarter of 2010 compared with a loss in the same period the previous year. Group revenue grew by more than 20%, reflecting a recovery in load factors and yields. Yield across all classes of travel grew 14.7%.

The airline reports a continuing recovery in operating conditions, and advance bookings for travel are especially encouraging in business class. This is cited as evidence that year-on year recovery in passenger carriage and yields will hold up for the remainder of 2010.

At the same time, Singapore Airlines has made a number of enhancements to its product. The difficulty is linking this with an improvement in revenue during a global economic upturn.

Like Singapore Airlines, Qantas now flies the Airbus A380. The introduction of the plane has allowed the carrier to revamp its front cabin offering. “We are constantly investing in new product, customer service, and innovation. We know this is valued by our passengers, and particularly our higher yielding customers,” says Alan Joyce, CEO, Qantas. The airline is to receive another five A380s in the 2011 financial year, boosting its A380 fleet to 11.

Like most other intercontinental carriers, Qantas has seen steady improvement in yields from a low point in mid-2009. It should be noted, however, that some routes have transferred from Qantas to Jetstar, which has a lower cost base.

Joyce says a focus on capacity will remain the main challenge for yield management, although he suggests that this is more of an issue for the lower end of the market. “Our yield improvements are getting better each quarter and, in the last quarter of the 2010 financial year, yield improvements on international routes were 12% up on the previous period,” Joyce notes. “This trend is continuing as the premium market recovers.”

Focus on the fleet

Joyce is clear that, while general conditions are improving, investment in fleet and product is a strong driver in improving yields. As such, significant investment in fleet and new customer initiatives remains a strategic imperative for the Qantas Group.

“We have about 160 aircraft on order for delivery in the next ten years, including the Boeing 787 for Jetstar and Qantas, and additional A380s for Qantas,” says Joyce. “We will also retain a strong focus on investing in customer product and service, innovation, and technology to complement the fleet renewal plan. In Australia, a major initiative that will really appeal to our domestic premium customers is Next Generation Check-in. This will change the way people check in and move through the airport to their flight. It will be a game changer.”

Jean-Claude Donzel, Senior Manager at Swiss, also believes product improvement can help yields but questions whether it can supersede other challenges. The airline has experienced a recovery in premium yields, particularly on intercontinental routes, and expects further growth. But restrictive corporate policies as well as strong competition will keep a tight lid on matters.

Swiss is in the midst of a significant overhaul of its premium product. Its new A330s have completely redesigned business and first-class areas. The front cabins of the airline’s A340 fleet are also being refurbished.

Two A340s—used to serve San Francisco and Boston—are already in operation with the new configuration and the remaining 13 aircraft will be revamped by mid-2011. Airport lounges in Zurich and Geneva have also been upgraded.

Donzel says product enhancement certainly impacts the airline’s position compared with its competitors. And he notes product also includes schedule and capacity improvements—vital components of passenger choice, as is a strong frequent flyer program.

“Punctuality and reliability also influence the attractiveness of an airline in the business travel sector,” he adds.

Meanwhile, Lufthansa has continued to maintain a strong interest in its premium travel offering. It has first class terminals and lounges at Frankfurt, Munich, and New York, and deliberately uses these to tempt premium passengers. Overall, yields are improving.

As with Swiss, Lufthansa’s emphasis is on intercontinental routes—where the quality of the cabin can make a considerable difference—with only sluggish yield increases in the European market. Cost  management programs are apparently still being pursued with vigor.

In the next five years, Lufthansa will invest about $1.5 billion (EUR1.2 billion) in its cabin equipment, furniture, and fittings. This includes a new first class in the A380 as well as a new business class with full flat seats for the Boeing 747-8.

Of course, it’s not just about pushing top-end yields. KLM decided to introduce a new premium economy product on its intercontinental fleet during the downturn. This catches premium travel that could have dropped even further and, in better times, can haul up revenue from the economy cabin floor.
The airline reports that results are better than expected and are contributing to an overall yield increase in its network.

Is the price right?

Despite the success, a KLM spokesperson warns that price is becoming ever more dominant. Product improvement alone may not be enough to ease the pressure on yields. Indeed, most statistics show that premium travel is clearly correlated with external factors.

First and business class travel dropped some 25% at the low point of the 2009 recession. Premium passenger numbers tend to mimic movements in world trade, which dropped 12.2% in 2009 according to the World Trade Organization. A recovery is not expected until next year at the earliest.

Nevertheless, differentiators in the front of the cabin could play a vital role. They may not allow yields to run against the grain when external drivers are pushing in a particular direction. But they can determine exactly how fast those yields improve or decline.

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